Congress throws fuel on already hot currency war

In case you missed it, there’s a currency war going on. It may not be the sexiest thing in the world to talk about, but it is important to understand. Probably the most important thing to understand is, in the midst of all this financial upheaval, it’s not healthy for anyone. In fact that best thing right now would be to back off and let things chill for a bit.

That’s why the US Congress passed a bill calling China a “currency manipulator.” So much for cool heads. Blame it on election year politics and the need to seem to be sticking up for America … even if what you’re really doing is adding more heat to an already ferociously hot situation.

The baseline here is the US believes the Chinese yuan is undervalued by about 25%. And it has been on China’s case for some time to get them to revalue their currency upward. That would make US exports more competitive against China.

But, there’s more to the story than just that.

First thing to know is because of the horrific global financial climate, “Japan, Brazil, Peru and countries all over the world are trying to beggar thy neighbor (just as happened during the 1930s) and gain a leg up for their exports by cheapening their currencies,” according to The Market Oracle. So we have any number of countries trying to boost exports at the expense of their currencies.

You have to then dial it back to June of this year to understand the second part that makes this so complex. June 19th specifically. Jack Perkowski explains:

That is the day that China, by far the world’s largest currency trader, announced that it would no longer peg the yuan to the U.S. dollar, but would instead peg it to a basket of currencies. What China’s announcement meant in practice is that at the margin, beginning on June 19, China would tilt its purchases in favor of buying assets denominated in the euro, the Japanese yen, the British pound or some other major currency, rather than those denominated in the U.S. dollar. When an investor with $2.5 trillion of buying power makes such a statement, markets tend to listen.

Here is what has happened since.

As of the September month-end, the euro has increased in value by 10.3% against the U.S. dollar since June 19, the pound by 6.3%, and the yen by 7.8%. In fact China’s purchases of yen-denominated securities has heightened trade tensions between Japan and China to the point where the Japanese have complained publicly that China is effectively pricing Japanese products out of the market with its yen purchases, threatening to derail Japan’s economic recovery.

In the broadest measure possible, the United States Dollar Index (“USDX”) has declined by over 9.6% percent since June 19. The USDX measures the value of the US dollar against a basket of currencies that includes the euro, yen, pound, Canadian dollar, Swiss franc and the Swedish krona — exactly the currencies that China is most likely including in its own basket and which are now appreciating as a result. The USDX began in March 1973 with a value of 100.000 and has since traded as high as the mid-160s. At its current level of 78.691, the USDX is approaching its 33-year low of 70.698, which was reached on March 16, 2008.

On the one hand you have countries everywhere trying to cheapen their currencies to sell their exports (China wants theirs to stay right where it is) in order to boost GDP growth. And on the other you have China’s move away from pegging the yuan to the US dollar to pegging it to a basket of other currencies, and driving those currencies higher and making their exports less competitive.

Unpegging from the US dollar has also driven the dollar down relative to those other currencies but still much higher than the yuan, which has only appreiated 2%.

Back to the point about the bill just passed by Congress. It doesn’t really help:

But the former U.S. trade representative, Susan Schwab, says that – while there's a very real problem in terms of China artificially keeping the renminbi low, this isn't the way to solve anything. Schwab calls it “a signal-sending exercise during an election season”. She says that the bill won't really do anything, even if the Senate passes it and it is signed into law. Schwab says it “makes no sense”, won't solve any problems, will escalate tensions, and will only divert attention from the real trade problems between the U.S. and China.

In fact the “election signals” may blow up in our face:

Indeed, Schwab warns that other countries might decide that this U.S. bill means that it’s open season for addressing currency manipulation, and that other countries believe that the U.S. is manipulating our currency. She says there could be a “boomerang effect” from the legislation.

All we’d need now to kill our recovery as weak as it is, is to have a full blown, open season, take no prisoners currency war where the dollar would be weakened even more than it is now. And that’s especially true if the “quantum easing” (printing more money) the Fed has been hinting about is about to take place.

What no one seems to want to admit is now is not the time for any country to be revaluing its currency upward. The US is demanding of China what it wouldn’t do itself. Until the financial crisis has passed, these demands that China push the value of the yuan up should be on hold. Then, as Zachary Karabell explains, it is in China’s best interest to see the value of the yuan eventually increase:

China has been revaluing its currency, nearly 20% between 2005 and 2008 and now nearly 3% since June when the government resumed that policy having shelved it during the midst of the global financial crisis. It is in the domestic interest of the Chinese government to raise the value of their currency because they are focused on building up on internal, domestic consumption market. They have no wish to be dependent long-term of the vagaries and whims of American consumers, and higher purchasing power for Chinese consumers is the answer. They are not revaluing quickly enough to suit an America stuck in second gear and looking for someone to blame, but revaluing they are.

And there’s the bottom line – the US recovery isn’t going as well as we’d like it and as seems to be the penchant among US politicians, they have to have someone else to blame for the problem.

Solution: throw gas on a raging fire. I sure hope China has cooler heads at the helm.